2011 Halftime Report: Oil Outlook Remains Strong

This year has been eventful for the oil patch. Natural disasters, revolutions,
terrorist attacks and political maneuvering kept oil bouncing around $100 per
barrel and 3.8 percent higher on the year at the end of June. Despite the volatility
and large number of external forces affecting oil prices, the International
Energy Agency (IEA) said in its most recent Oil Market Report that "the bull
run evident since autumn 2010 therefore looks in large part to be justified
by supply and demand fundamentals."

Oil industry analyst PIRA estimates incremental demand will outpace supply
by 1.1 million barrels per day on a year-over-year basis during the third quarter
of 2011. The U.S. Energy Information Administration (EIA) says long-term supply/demand
drivers indicate the market will remain tight for the foreseeable future as
growing demand from emerging economies for liquid fuels and slowing non-OPEC
supply growth "maintain upward pressure on oil prices." The IEA forecasts
oil prices to average $98 per barrel this year and $103 per barrel in 2012.

Oil Demand

The IEA forecasts the world will use 91 million barrels of oil per day in
2012, an increase of 1.5 million barrels per day. The IEA also revised its
2011 oil demand projections upward by 0.2 million barrels per day. Projecting
outward to 2016, the IEA's baseline scenario assumes a healthy 4.5 percent
global GDP growth and an average oil price of $103 per barrel. With these assumptions,
annual oil demand growth should average 1.2 millions barrels per day through
2016.

Emerging markets are almost entirely the source of this increased demand,
with China accounting for 41 percent of demand growth over that time period,
the IEA forecast says. The chart illustrates how developing (non-OECD) country
oil demand has dramatically increased since the mid-1990s while developed world
(OECD) demand has decreased. Through two financial bubbles and a global financial
crisis, non-OECD demand has stair-stepped its way to nearly doubling in less
than 20 years.

How is this possible? Many non-OECD markets have favorable demographics, rapidly
urbanizing populations and industrializing economies that have returned many
developing economies' GDP growth rates to pre-crisis levels.

Rising incomes have also outpaced rising oil prices and sustained emerging
market demand despite a general reduction in subsidies, the IEA says. Rising
wealth has also established a new global middle class that the World Bank estimates
will be more than 1 billion strong by 2030. In fact, the World Bank was cited
in a National Geographic article earlier this year forecasting that
for the first time ever, more people in the world will be classified as middle
class than poor in 2022. Today, roughly 70 percent of the world's population
is classified as poor.

Major emerging market countries, such as China, India and Saudi Arabia, have
reached the important GDP per capita range ($3,000-$20,000) where oil demand
historically "takes-off."

China carries the biggest stick among emerging markets when it comes to oil
demand. Strict tightening measures from Beijing and rising inflation slowed
the country's oil demand growth to its lowest level since 2009 in June. However,
China's oil demand is still expected to grow 7 percent this year, which is
inline with the country's five-year average demand growth rate, according to
Deutsche Bank. The summer months have historically been weak periods for oil
demand in China but Deutsche Bank estimates growth rates will recover during
the fourth quarter.

Chinese auto sales growth has slowed but still registered 10.9 percent year-over-year
growth in June. In an interview with Maria Bartiromo for USA Today,
Ford CEO Alan Mulally called China's car market a "very exciting development." The
company is projecting China's auto sales will reach 32 million by 2020--28
percent of the entire global market. Ford isn't the only U.S. auto manufacturer
tapping into China's booming auto market; General Motors' Buick brand is one
of the most popular in the country. According to the Brookings Institute, General
Motors sold 10 cars in the U.S. for every one car sold in China in 2004. Today,
that figure is nearly 1-to-1.

In the developed world, the outlook for oil demand is less bullish. OPEC says
the "austerity measures, combined with high levels of both debt and unemployment,
are likely to dent the fragile recovery in major OECD countries."

While demand growth in OECD countries is underwhelming, consumption rates
have recovered from recession lows at a much faster rate than many expected.
You can see that OECD demand contributed heavily to the recovery in global
oil demand from early 2009 to late 2010. In fact, the developed world contributes
little to global oil demand growth but still consumes more than half of the
world's total demand.

Despite China's rise, OPEC says the fate of the U.S. economy is the most influencing
factor for oil over the next 12 months. Oil demand in the U.S. was revised
upward in May and the U.S. economy is forecasted to see 2.5 percent GDP growth
in 2011.

PIRA says the U.S. economy is signaling strength in the second half of the
year. It cites business capital expenditures as improving, which generally
leads to employment gains and increased household consumption. It also expects
a 20 percent hike in auto manufacturing output from the second quarter and
an increase in consumer spending.

A big determinant of U.S. demand and consumer spending is gasoline prices,
which the EIA forecasts to average $3.56 a gallon in 2011--up from $2.78 in
2010. U.S. consumers have already shown to be sensitive to higher prices with
total motor gasoline consumption down more than 2 percent on a year-over-year
basis during the second quarter. While OPEC expects U.S. gasoline consumption
to return to normal rates, OPEC calls it oil's "wild card" for 2012. Gasoline
consumption could be negatively impacted by economic turbulence, such as a
dip in employment.

Oil Supply

Oil production was rocked by several unexpected outages during the first half
of 2011. The revolution in Libya, political divisions in Iraq, terrorist pipeline
attacks in Nigeria, accelerating drug violence in Mexico and instability in
Yemen have all negatively impacted oil production. PIRA puts the total loss
of non-OPEC production at 74 million barrels. This is more than the entire
amount of production losses in 2010.

Supply in the second half could also be affected by various factors such as
hurricanes, maintenance issues and decline rates. The EIA is projecting non-OPEC
crude production to increase by 540,000 barrels per day in 2011 and 740,000
barrels per day in 2012.

The IEA sees global production increasing by a little more than 1 million
barrels per day annually until 2016. This is a result of increased capital
expenditure, which has positively impacted existing assets and accelerated
new projects, the IEA says. High oil prices are generating new supply, but
non-OPEC growth is coming from higher cost areas, such as tar sands. Countries
such as Colombia, China, Canada and the U.S. are expected to see the biggest
gains.

OPEC production is expected to decline by roughly 300,000 barrels a day in
2011 and the EIA projects OPEC spare capacity to fall by 12.5 percent this
year from 2010 and then another 11 percent in 2012.

It's A Different Kind of Bull Market

If you've been around a while like me, you can remember the oil shocks of
the 1970s. Oil prices skyrocketed and Americans waited in mile-long lines just
to fill up their cars with gas. Today's prices might conjure up some of those
memories but we're living in a different kind of bull market today. BCA Research
says there are a few key reasons today's bull market for oil is much different
than the embargo-driven bull run from 1973-1980.

Non-OPEC supply jumped from 27 to 41 million barrels per day in response
to the embargo. Today, non-OPEC countries don't have the ability to ramp
up production like that. Even if they did, BCA says it wouldn't be enough
to keep pace with rising demand from developing countries.

OECD countries drove global oil consumption in the 1980s, accounting for
70 percent of total demand. Today, that figure has dropped to 50 percent
as the demand growth has shifted to emerging markets. Developing countries
are less susceptible to higher prices because of subsidies, making similar
demand destruction unlikely, BCA says.

Global spare capacity has vanished so much that almost any oil-producing
country, not just top producers such as Saudi Arabia and Russia, can cause
a price spike by withholding access to its resources, BCA says.

Today's oil market is much different than what we experienced back in the
1970s. Back then, countries such as China, India and Russia had no global footprint;
they were isolationists. Russia was tucked away behind the Iron Curtain. Today
these countries are building their economies and squeezing the existing supply
of the world's resources, including oil.

These factors indicate that growth in global oil demand will likely outpace
increases in production capacity and create a "tighter market" than what the
IEA expected back in 2010. As the IEA sums it up, "[the] market will ultimately
adjust to higher prices, albeit supply and demand remain unresponsive in the
short term. Indeed, oil's price inelasticity underpins the recent extended
upward price shift in the face of resilient non-OECD demand growth and perennial
supply-side risks."

None of U.S. Global Investors Funds held any of the securities
mentioned in this article as of 6/30/2011.

Frank Holmes is CEO and chief investment officer of U.S. Global Investors,
Inc., which manages a diversified family of mutual funds and hedge funds specializing
in natural resources, emerging markets and infrastructure.

The company's funds have earned more than two dozen Lipper Fund Awards and
certificates since 2000. The Global Resources Fund (PSPFX) was Lipper's top-performing
global natural resources fund in 2010. In 2009, the World Precious Minerals
Fund (UNWPX) was Lipper's top-performing gold fund, the second time in four
years for that achievement. In addition, both funds received 2007 and 2008
Lipper Fund Awards as the best overall funds in their respective categories.

Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a
leading publication for the global resources industry, and he is co-author
of "The Goldwatcher: Demystifying Gold Investing."

He is also an advisor to the International Crisis Group, which works to resolve
global conflict, and the William J. Clinton Foundation on sustainable development
in nations with resource-based economies.

Mr. Holmes is a much-sought-after conference speaker and a regular commentator
on financial television. He has been profiled by Fortune, Barron's, The Financial
Times and other publications.

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